Not making the cut

Rolling back rate cuts in small savings invites charge of political compulsion overriding sound economic policy.

Last week on Wednesday, the finance ministry announced cuts in interest rates on small savings instruments such as the Public Provident Fund and the National Savings Certificate in the range of 40-110 basis points for the April-June quarter of the current financial year. This resetting of interest rates on small savings schemes, aligning them with the yields on government bonds of comparable maturity, is a routine exercise, typically carried out every quarter. Yet, within 12 hours of announcing it, the government overturned the order, terming it an “oversight”. This rollback not only shines unflattering light on the manner in which decisions are made in the government, but also invites the charge of economic policy being made subservient to political considerations. West Bengal, which is in the midst of a bitterly contested assembly election, accounts for the highest inflows to small savings schemes. Cutting interest rates, which would impact the fortunes of savers, or voters, could affect a party’s electoral prospects, or so it is believed.

Interest rates on small savings schemes need to be aligned with rates in the broader economy. High interest rates on these schemes are often seen as impeding monetary transmission — bank deposit rates tend to be sticky on the downside as banks fear substitution by savers in favour of small savings instruments. Lowering these rates would thus improve the transmission of monetary policy. As an RBI report had noted, “public sector banks depend more on retail term deposits and face competition from alternative saving instruments like small savings, which constrains them from lowering rates in sync with the policy rate.” The gap between the two is strikingly large. In the third quarter of 2020-21, the report estimates that the difference between the interest rate announced by the government on small savings instruments and that arrived at from the formula ranged between 83-203 basis points.

Considering that the funds gathered through these instruments are used to finance the government’s deficit, higher interest rates also have a bearing on government finances. In 2021-22, the government’s borrowings through this route have been pegged at Rs 3.91 lakh crore. Thus higher interest rates on these instruments imply that the government will have to pay a rate over the existing market rate, increasing its interest obligations. These rates will ultimately need to be aligned with those in the broader economy. But reinstating the order in the aftermath of the elections, even as it will be the right thing to do, will only lend credence to the charge of political compulsions overriding sound economic policy.

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